Saturday, August 22, 2009
Inflation and its Causes
In ordinary sense inflation mean a general rise in prices. A rise in prices is the indication of inflation. Basically inflation represents a situation whereby the aggregate demand for goods and services exceeds the available supply of output.
In the Keynesian sense, true inflation begins when the elasticity of supply of output in response to increase in money supply has fallen to zero or when output is un-responsible to changes in money supply. When there exists a state of full employment the conditions will be clearly inflationary, if there is increase in the supply of money. But since we do not subscribe to the classical view that there is full employment we can say that when money supply increase it results partly in the increase of output (GNP) and it partly feeds the rise in prices. And when the supply of output lags for behind, the rise in prices is described as inflationary. In Coulborn’s words, it is a case of “too much money chasing too few goods” thus inflation is generally associated with an abnormal increase in the quantity of money resulting in abnormal rise in prices.
CAUSES OF INFLATION
There are so many causes of inflation in the less developed countries like Pakistan. Inflation may occur due to any one of the following reasons or causes.
1. Increase in Demand: Due to increase in population or due to change in certain other factors, the demand for goods and services measures supply remaining the same, expenditure will increase and inflation occur.
2. Lack of Supply: Due to some unfavourable climatic situations, political, social, national or international situation production remains low (small) in any particular year and supply will also decrease, prices will go up and inflation will occur.
3. Increase in the Cost of Production: In certain cases cost of production increases due to rise in the prices of factors of production, producer rises price level and due to excessive expenditure inflation occur.
4. Over Population: Inflation also occurs due to the increasing rate of growth of population. As Pakistan is an over populated country and the rate of growth of her population is about 3% per year, while the rate of production of goods is very low and due to this prices of commodities rise and inflation occur.
5. Development Expenditure: In under developed countries like Pakistan major amount of money is spent on the development programmes and due to increase in the income of the individuals, their expenditure is the basic cause of the inflation.
6. Food Problem: Pakistan is basically an agricultural country. Near about 30% of national income is had by agriculture sector. But unfortunately there is an acute shortage of food grain in Pakistan and so is the case with other developing and under developed countries of the world. The prices of other commodities are influenced by the continuous rise food grain prices and thus inflation occurs.
7. Financial Position of Common Man: In under developed countries, the financial position of a common man is very poor and there is a lock of saving because the major portion of income is spent on the purchase of only consumer goods.
8. Import of Machinery: Under developed countries spent lot of amount on the import of machinery. So the cost of production increase and inflation occur this price of goods also increase and inflation occur.
9. Expenditure on Defence: Of course defence is very important for every country. A huge amount of budget is spent on defence requirements in all countries of the world. Like other countries Pakistan’s major part of budget is spent on defence requirements. As we only produce 5% of total defence requirements within country and the remaining requirements are imported from abroad. Due to this reason inflation occurs.
10. Natural Climate: Natural climate play an important role in the economy of any country. Pakistan is basically an agricultural country we earn near about 30% of national from agriculture sector. Agricultural products wholly depend upon natural climate. Due to unfavourable natural climatic conditions when agricultural cross are destroyed or decreased as a result of this supply decrease and prices increase and inflation occur.
11. Deficit Financing: By deficit financing we mean that there is deficit created in budget when budget is announced. Expenditure is more than income in actual sense by deficit financing mean to issue new currency when this new currency came into the market it increases the demand of goods and services but on the other hand supply remain the same as a result of this price increase and inflation occur.
12. Decrease in Production: Inflation may occur if production decreases. There are many reasons of decrease of production e.g. natural climate, political, social conditions, competition, national and international problems etc which are cause of inflation.
MEASURES TO CONTROL INFLATION
The methods which are adopted to remove inflation, they are called anti-inflation measures. These measure may be of the following three kinds.
1. Monetary Measures
2. Fiscal Measures
3. Non-Monetary Measures or General Measures.
Let us discuss these turn be turn
1. MONETARY MEASURES
Monetary measures mean those measures which are taken by the Central Bank of the country. Anti-inflationary measures of pure monetary nature are largely a matter of Central Bank policy. These are discussed as under.
(i) Bank Rate Policy: In the time of need the people may discount the bills from commercial banks. When there is inflation in the country then banks should increase the rate so that people can not get cash by discounting the bills. This is the bank rate policy and is major weapon of controlling the inflation.
(ii) Open Market Operation: When Central Bank sales or purchases the securities in open market, it is called open market operation. If there is inflation in the country then central Bank should sell the securities so that the inflation may be controlled.
(iii) Higher Reserve Requirements: Higher reserve requirements are also necessary to control the inflation. Because of reserves are increased then purchasing power of people is also decreased.
(iv) Monetary Reforms: The Government can order to exchange old notes by new ones in this way a large part of money may be blocked. Money should be repaid to people after achieving the purpose.
(v) Marginal Requriement: Marginal requirements means the value of securities against which banks agree to advance loans. If banks increase the marginal requirement then people can not get more loans and inflation may be controlled.
(vi) Credit Rationing: Sometimes Central Bank advises to commercial banks to stop the advancing loans for one month or two months or more. In this way inflation may also be controlled.
2. FISCAL MEASURES
(i) Cut on Expenditure: If government decreases her expenditure on unproductive activities then inflation is also automatically controlled.
(ii) Change in Taxation System: Tax system should be reorganised to encourage investment and productive activities in the country. It may help to increase production and to control the general price level.
(iii) Restriction on Exports: Government may control inflation by applying restriction on the export of those goods which other wise may create shortage in the country.
(iv) Managing Public Debt: Public debt should be managed in such a systematic way that money supply is reduced and consequently the inflation may be removed.
(v) De-nationalization: To control the inflation government should de-nationalize sick public industries. The experience of nationalization of industries in Pakistan has been quite bitter for economy.
(vi) Protection to Infant Industries: To control inflation, increase in domestic production is required. So government should protect the domestic infant industries by applying import duties.
3. GENERAL MEASURES
(i) Population Planning: The demand of goods and services may be controlled by control of population growth. So effective population planning may also help to control inflation.
(ii) Co-operation between Monetary and Fiscal Policies: Government may control inflation, if there is a proper co-operation between fiscal and monetary policies.
(iii) Effective Planning: Administration and politician may help to control inflation by making policies for the interest of the whole nation and by sacrificing their personal benefits.
(iv) Increase in Output: Steps should be taken to increase the output, so that the shortage problem of goods can be removed. If there are sufficient products in the market in sufficient quantity. Then the too much money will not chase too few goods and in this way the inflation will automatically be controlled.
(v) Political Stability: Government should take the steps to remove the political crisis so that business sectors are encouraged to invest in the country. This is very positive and natural way of controlling inflation.
(vi) Discipline: There should be discipline in factories and offices so that output of the country may increase and inflation is controlled.
(vii) Hoarding and Smuggling: Hoarding and Smuggling should be controlled because if hoarding and smuggling are controlled then inflation is also controlled.
About : Raja CRN
Author description goes here. Author description goes here. Follow him on Twitter